Why tax planning should not be the key driver of investment decisions
Posted by: Arti Bhargava on Feb 03, 2020, 06.30 AM
Ishan has just started his career. Of late, he has been getting calls from vendors trying to sell him products with tax benefits, pushing him to invest in them before the financial year ends. The list includes PPF, Ulips, life insurance, ELSS, pension fund, and NPS, which takes his total tax deduction to around Rs 2 lakh. Ishan struggles to meet the annual target given his limited income, but the lure of tax saving is high.
Personal financial situations are different at different stages of life. As he is still young, Ishan can save and invest, but it is likely that his shortterm needs would be higher. By locking his money in tax saving products, which are typically long-term products, he might be making a mistake. He may find it difficult to keep up the investment required, or draw on it when needed.
This common mismatch, especially for young investors results in dormant PPF accounts, discontinued subscriptions and missed premium payments. If Ishan tries to access the money in need, he is likely to face penalties, lower realisation values or high costs. What he does to save taxes should, therefore, fit his overall personal financial situation and needs.
Tax planning is an integral part of financial planning, but should not be the key driver of investment decisions. Once he figures out his financial plan, putting aside money to make the most of the available tax breaks will become easier. Given his young age, if he finds that setting aside about 20% of his income for retirement is adequate at this stage, he may find that he is already doing it with his PF (Provident Fund). He may, therefore, not need PPF, NPS or VPF at this time.
For investors like Ishan, liquidity needs may be higher due to unexpected expenses in the early stage of their lives. He may need a term insurance much more than a Ulip; health insurance to cover his family; and might invest in a property and get tax breaks. It might be a wiser thing to actually pay the taxes and retain the flexibility.
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